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2015 First Quarter Report: Stop Awaiting the Fed

The first quarter of the new year brought us small positive returns in many of the U.S. and global indices, as well as more than the usual amount of anxiety along with them. The Wilshire 5000, the broadest measure of U.S. stocks, was up 1.61 percent for the first three months of 2015, which is remarkable considering that the index lost 0.75 percent on the last day of the quarter. The widely-quoted S&P 500 index of large company stocks posted a gain of only 0.95 percent in the first quarter of the year. Mid-sized stocks, as measured by the Russell Midcap Index, were up 3.95 percent, and the Russell 2000 Small-Cap Index was up 4.32 percent for the quarter.

Meanwhile, global markets are showing signs of life. The broad-based EAFE index of companies in developed foreign economies gained 4.88 percent in dollar terms in the first quarter of the year, in part because Far Eastern stocks were up 8.27 percent. In aggregate European stocks gained 5.15 percent, but they are still down more than 8 percent over the past 12 months. Emerging markets stocks, as represented by the EAFE EM index, didn’t fare as well, gaining 1.91 percent for the quarter.

Looking over the other investment categories, real estate investments were up 4.67 percent for the first quarter, despite falling 0.87 percent on the final day. Commodities, as measured by the S&P GSCI index, continued their losing ways, dropping 8.22 percent of their value in the first quarter, largely because of continuing drops in oil prices.

If you were watching the markets day to day, you experienced a mild roller coaster. Trading professionals refer to this as a sideways market; one day it was up and the next, down. As a result, each day (or week) seemed to erase the gains or losses of the previous one. The best explanation for this phenomenon is that investors are still looking over their shoulders at interest rates and waiting for bond yields to jump higher. A rise in yields would make bonds more competitive with stocks and could trigger an outflow from the stock market that could cause a bear market in U.S. equities (so the reasoning goes).

However, investors have been waiting for this shoe to drop for the better part of three years, and meanwhile, interest rates drifted decidedly lower in the first quarter. The 30-year Treasuries are yielding 2.48 percent, roughly 0.3 percent lower than in December, and 10-year Treasuries currently yield 1.87 percent, down from 2.17 percent at the beginning of the year. At the low end, you need a microscope to see the yield on 3-month T-bills, at 0.02 percent; 6-month bills are only slightly more generous, at 0.10 percent.

This interest rate watch has created a peculiar dynamic where up is down and down is up, in terms of how traders and stock market gamblers look at the future. The generally positive economic news is greeted with dismay, and any bad news sends the stock market back up again into mild euphoria.

We all should welcome the Fed pullback, not fear it. Much of the uncertainty among traders and even long-term investors is coming from anxiety over how this experiment, known as Quantitative Easing, is going to end. The U.S. central bank has directly intervened in the markets and in the economy, and it is still doing so. When that action ends, normal market forces will take over, and we’ll all have a better handle on what “normal” means in this economic era. Is there great demand for credit to fuel growth? Would retirees prefer an absolutely certain 4.5 percent return on 30-year Treasury bonds or the less certain (but historically higher) returns they can get from the stock market? These are questions that all of us would like to know the answer to, but we won’t until all the Quantitative Easing interventions have ended.

What do we know?The U.S. economy is less dependent on foreign oil than at any time since 1987, and the trend is moving toward complete independence. Oil—and energy in general—is cheaper now than it has been in several decades, which makes our lives, and the production of goods and services, less expensive.

Meanwhile, more Americans are working. The U.S. unemployment rate—at 5.5 percent—is trending dramatically lower, and it is now reaching levels that are actually below the long-term norms. Unemployment today is lower than the rate for much of the booming 1990s and is approaching the lows of the early 1970s.

Also, real GDP, the broadest measure of economic activity in the U.S., increased 2.4 percent last year, after rising 2.2 percent the previous year. America is growing—not rapidly, but slow growth might not be so terrible. In the past rapid economic growth has often preceded economic recessions, where excesses had to be corrected. Slow, steady growth may be boring, but it’s certainly not bad news for the economy or the markets.

It has been said that people lose far more money in opportunity costs by trying to avoid future market downturns while the markets are still going up than by holding their ground during actual downturns. In fact, in every case so far, the U.S. market has eventually made up the ground it lost in every bear market we’ve experienced. The last trading day of the quarter looked bearish, as have many other gloomy trading days during this seven year bull market. It seems like every week somebody else has predicted an imminent decline that has not happened, and people who listened to the alarmists lost out on solid returns. Remember, you should filter out the good news at your own peril.